Disruptive Innovation

If they can adapt, payers will have far more power than fragmented physicians, other providers, employers, and patients to shape the new environment

Stephen Wunker

David Duncan

While the health care policy debate in Washington continues to center largely on who is provided insurance coverage, managed care organizations know that the primary business issue confronting health care is distinct: Cost increases have become completely unsustainable, particularly in a recession.

From 2000 to 2007, U.S. health care premiums rose 98 percent, while wages rose only 23 percent. Per capita U.S. health care spending is twice the average of the industrial world, and yet the country ranks only 37th in life expectancy. Listening to the politicians, it would be tempting to think that payers are raking in profits from this growth in spending, and yet business people know this is anything but true. The traditional payer business model has come under increasing pressure in recent years, and this pressure has threatened its very viability.

In fact, business models across the health care system are broken, and payers and others are starting to face the consequences. Plan sponsors are looking for lower-cost means of fulfilling their obligations to employees, including raising deductibles. Some are dropping coverage altogether. Physicians and hospitals feel that they are already at the breaking point, and many have no idea how they would deal with the steep cut in Medicare payments that seems to loom every year. Payers are caught in the middle, squeezed from all sides.

Our firm, Innosight, founded by Harvard Business School Professor Clayton Christensen, has researched business model innovation in dozens of industries. Our conclusion is that payers are suffering from many of the maladies of other industries with broken business models. Curing these ills is not easy, but a handful of organizations are showing the way.

What is a business model?

What do we mean by business model? In an article in the December issue of the Harvard Business Review, we define a business model as consisting of four components. First, there is the value proposition delivered to customers. Then, there is the way the company makes money from delivering this value proposition (what we call the profit model). It must then assemble resources such as people and assets to make this happen. And finally, it coalesces this delivery model through a set of processes which gel the system into place.

A core driver behind many of the problems with today’s health care system is the seemingly haphazard integration of very distinct business models under the same roof. For example, a general hospital creates complex treatment plans, deals with routine injuries, and catalyzes interactions between patients and caregivers. This state of affairs evolved for explicable, historical reasons. Unfortunately, combining the business models needed to deliver these propositions invites dysfunction, as each business model makes money in a distinct way, needs different resources and processes, and has different success factors. The result is high overhead, inefficiency, and frustrated physicians, administrators, and patients.

Future business models in health care

When the different business models function independently, the picture is very different. National Jewish Medical and Research Center in Denver is focused on pulmonary disease. The Center brings together a cross-functional team of physicians to diagnose and treat disease that has not responded to previous therapy. It achieves outstanding medical outcomes at reasonable average cost. In contrast, Minute Clinic also achieves first-class outcomes at excellent cost, but only if the patient has one of a small list of very common, easily diagnosed, and straightforwardly treated conditions. DLife.com brings together diabetics and the organizations that serve them at low cost and with high user loyalty. Each of these organizations is able to organize a profit model, set of resources, and internal processes in such a way as to deliver its customer value proposition effectively and efficiently.

Separating out business models in today’s health care system requires scale and market authority. It is easier to get married than to get divorced. Managed care organizations will need to disentangle activities into distinct providers with separate delivery models, according to the type of value proposition required. There are very few businesses in which an organization succeeds by being everything to everybody.

Forcing change will require integrating with physicians, and in this respect, the more integrated organizations such as Kaiser Permanente are in a stronger position vs. the more traditional insurers such as the Blues.

Payers need not employ physicians directly, but will need to strongly align incentives through pay-for-performance, capitation, or other mechanisms. Integration has enabled organizations like Kaiser Permanente to invest heavily in innovations such as electronic medical records (EMRs), telemedicine, and preventive care. It has lengthened the tenure of subscribers in health plans because patients are less likely to change physicians than they are to change employers. Longer tenure has made many interventions cost-effective for Kaiser Permanente while they remain prohibitive for traditional insurers.

Payers will also need to construct business models tailored to emerging value propositions. In particular, the potential decline of employer-based insurance — because of laws that enable insurance portability or economic pressures forcing employers to drop benefits — may require payers to be far more solicitous of the subscriber than in the past. While payers have long serviced subscribers, few have become expert at selling to them or trying to earn their long-term loyalty through customer service. A new, subscriber-facing value proposition requires a distinct profit system — one that makes money by having subscribers with much longer tenure than before — and a set of resources and processes that may be unfamiliar to many payers.

A vast expansion of EMRs, as proposed by President-elect Obama as part of the fiscal stimulus, would have profound implications on the business model of payers. Widespread use of EMR technology would enable payers to exert much more real-time power over clinical decisions, much as the National Health Service is able to conform medical practice in the United Kingdom to accepted standards to a far greater degree than in the United States. Payers could adjudicate more claims at the point of care, reducing conflict with physicians. They could implement pay-for-performance criteria more effectively than at present, and they could steer patients to physicians with the best treatment records. Physician practice groups could fracture, as government support for EMR implementation and interoperability would remove a large incentive for consolidation. Payers could become powerful coordinators of care.

How can MCOs prosper?

With such profound changes possible in the payer business model, how can managed care organizations prepare for the future? First, they need to examine their current set of mixed business models, blueprinting the four parts discussed above and their critical interrelationships. Through this process, they should ascertain which parts of the aggregate business model are like the body’s endocrinology — a highly interdependent system disturbed at great peril — and which are extremities that can be operated on with relative ease.

Then, companies need to assess how that business model may need to shift in response to varying scenarios of change. This task sounds straightforward enough, but the reality is that most organizations approach it backward.

Business schools teach that strategy starts from a dispassionate review of market opportunity, followed by strategic targeting of specific opportunities, which then drives financial models, structures, and processes. In reality, many organizations take their profit formulas, resources, and processes as fixed — thereby constraining the types of value propositions they can deliver — and then bemoan the fact that they cannot invent truly innovative offerings to complete the equation. Creating strategy this way is like driving by looking in the rearview mirror. It is not an approach suited to environments of rapid change.

By driving business model innovation from a deep understanding of the marketplace — patients, physicians, and employers — payers can define what their stakeholders will demand under various scenarios. For instance, how would a vast expansion of the Federal Employee Health Benefits Program, as proposed by Sen. Tom Daschle, nominated to be secretary of health and human services, affect how these stakeholders define quality? How would a federal equivalent of the UK’s National Institute for Health and Clinical Excellence (NICE), also proposed by Daschle, affect differentiation among payers?

Subsequently, payers can define the other parts of their business model needed to deliver value propositions suited to this changing strategic environment. By rooting themselves in a common view of the world — though one that paints varying scenarios of change — they can objectively assess how profit systems, resources, and processes may need to adapt.

Like amending the law, shifting business models should be difficult. Dislocation creates inefficiency and uncertainty. Therefore, payers may wish to experiment with new business models on a small scale. Just as an entrepreneur would test varying approaches before raising a large amount of money to scale up, so too an established payer will need to adapt and learn. For instance, it may file new plans in just one state, or work with only one hospital system to pilot novel propositions.

It is perilous to ask the people charged with delivering today’s business results to create tomorrow’s business model. The urgency of everyday tasks will often push decisions about the future to the back burner. Worse, executives can unwittingly transplant the unwritten rules governing decision-making in the core business to new ventures that must break rules to survive.

A handful of organizations are pointing the way forward. By focusing business models and integrating with physicians, Geisinger Health System in Pennsylvania guarantees the price of a heart operation, no matter what complications might follow. Even the drug giant Pfizer has experimented with its business model to provide total health care products: In return for Florida putting all of Pfizer’s drugs on the state’s Medicaid formulary, Pfizer agreed to payment based on the results of an independent audit of systemwide cost savings from patients using their drugs. The strategy worked; Florida saved nearly $42 million and Pfizer avoided up-front discounts and back-end rebates.

With health care under tremendous cost pressure, change must happen. Influence stems from following the money. Payers control the lifeblood of the health care economy, and have far more power than fragmented physicians, providers, employers, and patients to reshape the environment. Payers can play a critical role by coordinating care, enabling prevention, ensuring quality, and empowering consumers. The future of managed care organizations will be turbulent. If payers can let go of past business models to create new approaches, that future can also be bright.

Stephen Wunker and David Duncan are partners in Innosight, a consulting firm founded by Harvard professor Clayton Christensen that focuses on “creating new growth platforms and reinventing business models.”

Executives can unwittingly transplant the unwritten rules governing decision-making in the core business to new ventures that must break rules to survive.

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